It is often said that as countries climb from low- to middle-income status, income inequality typically worsens before getting better. Whether this is an iron-clad law or not, what is true is that inequality in middle-income countries — such as Brazil, [People's Republic of] China, Mexico or the Philippines — could cap continued high growth and contribute to the “middle-income trap”.
Economic growth typically retreats from high rates as a country’s income levels rise. One reason for this is that those achieving high income are already operating closer to the frontier of possibilities, while those that haven’t still have room to expand. China and India, low-income countries until recently, posted exceptional growth rates. But they and others are finding it increasingly difficult to sustain the same high growth rates.
One path for sustaining growth in middle-income countries is to more effectively draw on the talents of all people, especially those with lower incomes. Just as low-income countries find more paths to the frontier of possibilities in the global economy, so do poorer populations within a country — provided their opportunities widen.
So if more growth is allowed to come from the poorer segments of society, that is, if growth is increasingly inclusive, countries can better avoid the middle-income trap. The earlier positive experiences of Japan and South Korea support this view.
But there is one important qualification learned from experience, including in the former socialist countries. The goal ought not to be equal outcomes regardless of the effort. Such an approach hurts competition and weakens incentives to excel. Instead, it might be better to level the playing field, eliminate special enticements for lopsided development, and improve efforts to engage all segments of society.
For decades, high inequality in countries such as Brazil and Mexico did not augur well for their growth prospects. But they became notably more equal in the past two decades. Meanwhile, the once more equal countries — such as China and India — have now become less so, signaling a degree of convergence in inequality across Asia and Latin America. These experiences offer lessons for policymakers and economic managers going forward.
First, building on the impressive record in many countries of widening access to basic education, we need action to increase entry into secondary and tertiary education as well. In Asia and elsewhere, the focus ought not to be solely on access to education, but on the harder goal of the quality of education.
Moreover, the skills an educated labor force acquires should better match the skills the labor market needs. Education and training need to respond to changing environments, and industry needs to be aware of the stock of skills available in the labor market.
Second, economic sectors with high labor intensity deserve special attention, especially in view of the harmful effect of their neglect, as in Asian agriculture. This is particularly important as food prices have risen in recent years. Improving agricultural productivity and efficiency can help not only the rural poor by increasing their incomes, but also the urban poor by lowering food prices.
Current policy advice in countries and multilateral development banks refers to the importance of reversing the decline in agricultural investments. In following up on this advice, it would pay countries to capitalize on key links with agribusiness and small and medium enterprises to see a rise in employment and productivity.
Third, countries need to capitalize better on remittances from abroad and other financial flows. Remittances have remained relatively robust, even in the midst of the financial crisis. Better incentives and stronger financial infrastructure for channeling a greater proportion of remittances for productive investment can help small businesses to flourish and stimulate job creation.
Fourth, a state that is accountable to its citizens, with the political resolve to ensure checks and balances that help to reduce the elite capture of a society’s resources, is essential. Varying efforts in China, India, Indonesia and the Philippines at establishing organizational structures to deliver better results in service provision, while combating corruption, are a much-needed component. Well-targeted programs for social protection can also make a timely difference, as Brazil and Mexico have learned.
Acting on these fronts involves consistent fiscal commitment and the political will to take on entrenched interests, but the societal gains are worth the effort.
So, yes, more inclusive economic growth is desirable for sharing the fruits of progress; but even more so, it is essential to sustain high growth in middle-income economies such as Brazil or China.